This will be a short article.
The Gabelli Utility Trust (NYSE:GUT), a leveraged CEF investing in U.S. and international utilities, is currently trading at a whopping 84.2% premium to NAV.
It is the highest premium in GUT's entire history and by quite a margin. The fund has only traded somewhat close to these levels during a couple of days in June of 2009 and January of 2010, and the premiums didn't last long:
GUT's premium is also highest in the entire CEF space, and it is not even remotely close. Consider the 10 CEFs with the highest premiums:
(Source: Cefconnect - chart by author)
As can be seen above, GUT's premium is more than three times as large as that of its closest peer, the DNP Select Income Fund (DNP), and no other fund has a premium greater than even 30%. GUT is really on a class of its own.
Excessive premiums are detrimental to shareholders for three key reasons.
First is the fact that excessive premiums can cause significant underperformance and shareholder losses when these narrow. As a quick example, GUT's shareholders suffered losses in excess of 20% during 2010, as the fund entered the year with a +70% premium to NAV. Losses were exclusively due to narrowing premiums, as NAV returns were outstanding at 18.19%:
In my opinion, GUT's shareholders are going to experience double-digit losses when, not if, premiums narrow to more reasonable levels. Management seems to agree:
The Fund’s shares are currently trading at a premium to net asset value. The Board of Trustees believes that the premium at which the Fund shares trade relative to net asset value is not likely to be sustainable. Shareholders participating in the Fund’s dividend reinvestment plan should note that at the current market price, the reinvestment of distributions occurs at a premium to net asset value.
(Source: GUT Newswire)
Second is the fact that excessive premiums significantly lower a fund's distribution rate, directly reducing shareholder returns. If the fund were trading at its NAV per share price of $3.68, shareholders would be entitled to a 16.3% distribution yield, an extremely enticing yield, and almost twice as large as the fund's current distribution. Investors might consider initiating a position in GUT once the fund's premium narrows, to receive a comparatively stronger yield.
Third is the fact that excessive premiums combined with return-of-capital distributions, like those of GUT, necessarily lead to shareholder losses. The logic of this is surprisingly simple. Imagine if the fund were to completely self-liquidate tomorrow. Investors would receive $3.68 per share, equivalent to the fund's NAV per share, which is about 45.7% lower than the fund's current share price of $6.78. Shareholders would, in effect, suffer losses of 45.7% if the fund were to completely self-liquidate.
Now, the above is obviously not going to happen, but GUT does sell some of its assets to fund its monthly distribution, which should have a similar, but smaller, effect. GUT's distribution is almost entirely return of capital; hopefully no investor thinks utilities could possibly yield 16.3%, with a distribution coverage ratio of only 19.0%, as per the fund's latest annual report:
(Source: GUT Annual Report)
Considering the figures above, it seems that GUT is forced to sell about 9-10% of its assets every year to fund its distribution. This is obviously unsustainable and should lead to shareholder losses due to the aforementioned reasons.
As a final point, I believe that investors should be willing to pay hefty premiums for high-quality funds with market-beating performance. PIMCO fixed-income CEFs come to mind. GUT is definitely not such a fund, as it has underperformed its index on a NAV basis for the past decade or so:
Performance is rapidly worsening, with the fund posting double-digit losses for the past year, far in excess of its index:
GUT's shareholders have been spared the worst due to the fund's skyrocketing premium:
GUT did perform exceedingly well during the 2000s, but I'm not sure that investors should put too much weight on performance from 10 to 20 years ago:
GUT's excessively high premium to NAV will almost certainly lead to significant shareholder losses in the coming months. Shareholders should strongly consider selling their shares now, both to avoid future losses and to lock in present gains.
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This article was written by
Juan has previously worked as a fixed income trader, financial analyst, operations analyst, and economics professor in Canada and Colombia. He has hands-on experience analyzing, trading, and negotiating fixed-income securities, including bonds, money markets, and interbank trade financing, across markets and currencies. He focuses on dividend, bond, and income funds, with a strong focus on ETFs, and enjoys researching strategies for income investors to increase their returns while lowering risk.
I provide my work regularly to CEF/ETF Income Laboratory with articles that have an exclusivity period, this is noted in such articles. CEF/ETF Income Laboratory is a Marketplace Service provided by Stanford Chemist, right here on Seeking Alpha.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.